Economists: Don't worry, depression isn't coming

MARY ELLEN PODMOLIK and MIKE HUGHLETT THE ASSOCIATED PRESS

Tuesday

Sep 30, 2008 at 12:01 AM

CHICAGO - Hearing some of the dire predictions for an economy struggling to avert a financial collapse, it's easy to recall 1930s photos of people huddled in soup lines or traveling the country for work, and wonder what a depression would look like in the modern world.

Experts say that won't happen. Yes, banks are failing and the stock market plunged Monday. And yes, there is genuine concern that, regardless of the government's $700 billion bailout proposal, the United States still could land in a severe recession.

But despite the alarms, including dire warnings from President Bush, economists insist there is no risk of a second Great Depression because, for some time now, the U.S. economy has been in the midst of a very different, less-threatening phenomenon: ''the Great Moderation.''

Coined by a Harvard economist earlier this decade, the term refers to a U.S. economy shaped by more flexibility and far less volatile swings in growth. That flexibility, fueled by everything from financial deregulation and global trade to the shift toward a service economy, will keep the nation from sinking into a depression.

''The Great Depression should not be the reference point,'' said Erik Hurst, an economics professor at the University of Chicago's Graduate School of Business.

''When (Bush) says 'there goes the economy,' that doesn't mean one in four of us will be out of work. It means we're going to have a recession. There could be a drag on U.S. productivity for four to five years. We may get 1 or two years with little or no growth,'' Hurst said.

Is there any possibility of repeating a period in history when the nation's jobless rate reached 25 percent and economic output fell by one-third, as it did during the Depression?

''Zero, just zero,'' said Kenneth Rogoff, a Harvard University economics professor. ''Ten percent, that could happen. If we got to 10 percent, that would be pretty spectacular for the U.S. But it would take a lot of mistakes (by Congress) for a long time . . . if Congress takes the ball and it fumbles.''

James Galbraith, a University of Texas economist and son of the late, well-known economist John Kenneth Galbraith, calls the possibility of another Great Depression ''overheated rhetoric'' because the federal government plays a far larger role in the economy than it did during the 1920s and 1930s, both in terms of government spending and regulation. For instance, the Federal Deposit Insurance Corp. began insuring bank deposits in 1934 to protect depositors from bank failures.

''When the private economy collapsed, that was the whole economy,'' Galbraith said. ''The banking system entirely collapsed in the 1930s. That's not going to happen. The worst-case scenario (now) is that losses in the banking system just get worse and the economy will slip into a recession.''

A better reference point that economists point to is the recession of the early 1980s, triggered by the Federal Reserve Board's efforts to curb runaway inflation by raising interest rates. By September 1982, the overall jobless rate reached 10.8 percent, the first time it had climbed into double digits since the Depression.

In 1982, at least one member in 8 million families was unemployed, accounting for 13 percent of all families. The housing, automobile, aircraft and steel industries all were hit. High oil prices reduced the demand for oil and gas, putting 150,000 miners out of work in a single year. Residential construction slowed because of high mortgage rates. Meanwhile, jobs in the services sector grew, but at a slower pace than previously.

Of course, the hope has been that the bailout package, designed to buy up bad mortgage investments from financial institutions, will free lenders of that burden and help get the credit market moving again, thus reviving the economy. No one knows if the current version of the bailout plan will win approval in Washington, if the gambit will work, or how quickly, but the risk remains that the U.S. will settle into a harmful malaise, and there will be losers.

The financial and construction industries will continue to lose jobs.

Housing prices will continue to plummet - some economists predict for a few more years - because there is still an oversupply of housing.

A. Gary Shilling, who heads his own economic consulting firm, predicts that home values, which already are down 18 percent from their high in the second quarter of 2005, will drop another 18-19 percent by 2010. That would mean 25 million people with mortgages, or one-third of all homeowners, would owe more on their homes than they are worth, he estimated.

As a result, homeowners will have less equity in their homes, and tightening credit policies mean consumers will have less spending money. Businesses will fail and jobs will be lost.

''Recessions aren't lethal,'' said David Stowell, a finance professor at Northwestern University's Kellogg School of Management. ''People should be extremely cautious, not hysterical, in their personal management, irrespective of what happens in the coming weeks. We all need to be very careful and prudent in how we spend money.''

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